The Government has proposed allowing the Prudential Regulation Authority to approve liabilities insurers feel are less exposed to market volatility and so require less capital to be held against them.
Introduced as part of Solvency II, the “volatility adjustment” mechanism is intended to reduce the capital required to be held against those liabilities that are unlikely to be impacted by day-to-day fluctuations in market prices.
Handing national regulators approval rights over use of the VA was put forward because the EU-wide mechanism can be applied to all liability types, leading to concerns that insurers may not hold enough capital to support more volatile liabilities.
The Government consultation says: “The [volatility adjustment] raises prudential issues because its design permits the measure to be applied to all liability types and not just those which would genuinely allow insurers to safely hold assets over the long term.
“The Government’s view has been that the VA may be much less appropriate for liquid or volatile liability types, such as those where there can be sudden large claim payments, or where policyholders can surrender their policies in exchange for a guaranteed amount.
“In such cases, assets may unexpectedly need to be sold at depressed prices, leading to losses.”
PricewaterhouseCoopers Solvency II leader Paul Clarke says the EU’s decision to allow the VA mechanism to be applied to any liability is an attempt to make the directive relevant to all 28 member states.
He says: “This is the result of the work being done by policy makers from 28 member states all with different markets. The intent is not necessarily to create reckless investment by insurers but to allow for those differences.”
The final Solvency II rules need to implemented by 1 January 2016. The consultation says if the Government decides to go ahead with regulating the volatility adjustment, the PRA will begin taking applications in the last three months of this year.